26.12.24 Analytics

The End of Euphoria and Manual Control: Economic outcomes of 2024 and the key challenges for 2025


The end of 2024 brought a slew of bad news for the Russian economy: inflation is accelerating, the ruble is weakening, and the balance of payments surplus is shrinking. Inflation has confidently entered a trajectory of double-digit annual rates despite the efforts of the Central Bank, reflecting the unbalanced growth model of Russia's wartime economy. As a result, even the anticipated 4% GDP growth for the year does not appear to be an achievement.

The debate over methods to combat inflation among Russian authorities concluded with a compromise that simultaneously diminished the Central Bank's de facto status. The Central Bank agreed not to raise interest rates further in exchange for the government's promise to limit preferential lending programs. Monetary policy, thus, has shifted partially into a mode of manual control.

The new policy aims to preserve both economic stability and significant growth rates. Its primary tool is the manual management of credit flows through macroprudential measures and fine-tuning the preferential lending system via government decrees.

To achieve these goals, inflation must decrease in 2025 at a faster rate than economic growth. Otherwise, the Russian economy risks entering stagflation. In practice, the proponents of the new policy face a threefold challenge: rapidly reducing inflation, maintaining production levels in the military sector, and stimulating output in the consumer sector. However, given the current realities of the Russian economy, this challenge seems insurmountable.

An additional challenge for the economy next year is the likely decline in oil prices, potentially exacerbated by new sanctions against Russian oil and gas or a price war in the market. This scenario threatens not only to reduce budget revenues but also to further weaken the ruble and cut imports, significantly increasing inflationary pressure on the market.

The likelihood of such a scenario enhances the Russian leadership’s interest in both halting military actions and achieving some relaxation of sanctions – issues being discussed in connection with the so-called 'Trump Plan.'

Overheating thermometer

The era of economic euphoria, driven by a significant boost in additional revenues from foreign trade and the use of the National Wealth Fund in 2022, has come to an end. The final months of 2024 have brought a string of bad news for the Russian economy. Annual inflation hovering on the brink of double digits, coupled with an extremely high key interest rate of 21%, ruble instability, and a shrinking balance of payments surplus, are the main indicators of the emerging economic distress.

Although Vladimir Putin has already announced an annual economic growth rate of about 4% (down from 4.9% in 2023), this too no longer qualifies as good news. The economy is slowing down (5.4% in the first quarter, 4.1% in the second, 3.1% in the third), albeit gradually. Based on Putin's forecast, growth in the fourth quarter is also expected to be around 3% year-on-year, partly fueled by massive year-end budget spending. This indicates that the economy remains overheated.

As we previously wrote, in 2023–2024, the Russian economy exhibited a form of 'growth scissors': the industrial investment sector and industries related to the military grew at faster rates than consumer-oriented production (→ Re:Russia: Who Will Break The Camel's Back). Meanwhile, a labour market deficit – driven by high demand for labour in the defence sector and an artificial reduction in the productive workforce by at least 2% – has led to increased real incomes and unmet solvent demand, laying the groundwork for high inflation.

In the week from 17 to 23 December, consumer prices rose by 0.33%, according to Rosstat. Despite another key rate hike on 16 October, inflation began to accelerate again in early November, peaked in the first half of December, and then stabilised over the past two weeks. As of December 23, year-to-date price growth stood at 9.5%. If the final week of the year sees a further acceleration to 0.47%, annual inflation will surpass the 10% mark, becoming officially double-digit. Even if this does not occur, December’s price growth is almost certain to exceed October’s figure of 1.43%, signaling that inflation has been on a double-digit trajectory for at least two months.

Price growth in October-December 2024, %

A recent survey conducted in early December by inFOM, recorded an increase in both inflation expectations and perceived inflation compared to November, rising from 13.4% to 13.9% and from 15.3% to 15.9%, respectively. Enterprises' price expectations also increased, reaching their highest level since the crisis of April 2022, according to a survey conducted by the Central Bank. Businesses attributed the anticipated rise in product prices over the next three months to upcoming increases in tax burdens, the minimum wage, and utility tariffs.

Manual monetary policy and the Central Bank’s new status

The final months of 2024 were marked by debates among businesses, the government, and the Central Bank over methods to combat inflation. The most recent rate hike to 21% sparked sharp criticism of the Central Bank chair by major and state-affiliated businesses. The Russian Union of Industrialists and Entrepreneurs (RSPP) reportedly submitted proposals to the government to amend the Central Bank law, mandating that key Central Bank documents be approved by the government. However, no such document appeared on the RSPP website, and the government claimed it had not received the proposals (→ Re:Russia: In the confrontation between the ‘growth party’ and the ‘Nabiullina party’, the ‘war party’ will prevail; in reality, such a document never appeared on the RSPP website, and the government said it had not received it).

Speaking at the ‘Russia Calling!’ investment forum, Putin adopted a harsher tone toward the Central Bank, stating that addressing inflation requires 'coordinated joint actions by the government and the Bank of Russia,' adding, 'This is not a request, not a wish, but, I believe, a direct directive to act.' This was a rare public instruction from Putin to the bank, which he has traditionally emphasised as independent. At his annual ‘direct line’ Q&A, Putin again criticised the Central Bank for its flawed methods of combating inflation, dismissively referring to its board of directors as a 'Komsomol cell' (the board’s decision-making process is a cornerstone of the Central Bank's institutional independence). The next day, the Central Bank held its key interest rate steady despite inflationary trends and other indicators suggesting the need for an increase.

The head of the Central Bank Elvira Nabiullina gave several reasons for this unexpected decision. First, monetary conditions had tightened more than anticipated following the last rate hike. Until October, the spread between the key rate and market rates for the most reliable borrowers was 2-3 percentage points; now, it is 5-6 points – effectively equivalent to raising the key rate to 24%, Nabiullina noted. Second, the Central Bank observed growing signs of an economic slowdown: companies were scaling back plans, delaying projects, and cutting investments and borrowing. A subsequent report on the banking sector confirmed a slowdown in corporate lending in November, from +2.3% month-on-month in October to +0.8%. The report linked this to banks largely depleting previously accumulated capital reserves for rapid growth and preparing for the imminent introduction of a countercyclical capital buffer requirement. The slowdown in corporate lending persisted into December, as Central Bank officials noted during a press conference.

However, the view that the Central Bank 'caved in' oversimplifies the situation. The compromise, reached under Putin’s pressure, shifts the Central Bank’s focus in the fight against inflation toward macroprudential measures (tightening requirements for financial institutions and their loan portfolios), while the government commits to limiting budgetary lending to the economy. Previously, raising the key rate increased the cost of commercial credit but had little impact on budget loans to enterprises at preferential rates.

The government’s intent to revise its approach to subsidising rates for preferential loans is reflected in a draft resolution, highlighted by ‘Kommersant’. The current system supports floating interest rates tied to the Central Bank's key rate. The more valuable the borrower is to the state, the better the terms they can receive. For instance, high-tech producers serving the defence industry have their interest expenses exceeding 5% per annum fully covered by the Ministry of Industry and Trade. This means that regardless of how high the Central Bank raises the rate, these companies still borrow at 5%. According to Kommersant, in the first half of 2024, subsidies were provided for rates under 65 preferential lending programs, with total loan obligations under these programs reaching 15.6 trillion rubles.

Under the new resolution, the state will cover no more than 5 percentage points annually for obligations taken on in 2025-2026 and no more than 3 points starting in 2027. This implies that if the key rate remains at 21%, the minimum rate for borrowers in 2025 will be 16% annually. Exceptions are provided only for subsidies included in long-term projects such as public-private partnerships and concessions. No sectoral exceptions (e.g., for the defence industry) are currently specified in the document. However, hints that such exceptions may be made can be inferred from Putin’s speech at the 'Russia Calling!' forum.

This shift signifies that monetary policy is now operating in a manual control mode. The Central Bank has acknowledged that its primary tool – the key interest rate – has limited influence on the market, and various borrowers will access funding at different costs as determined by government decisions.

When, in the spring of this year, Putin's economic advisor Maxim Oreshkin was also appointed deputy chief of the Presidential Administration (a precedent-setting move), we speculated that this was intended to elevate his role as a coordinator of government-Central Bank relations and gradually integrate the Central Bank into the executive branch’s structures (→ Re:Russia: The Last Term’s Great Game of Solitaire). The current 'compromise' reflects this integration process and signals both a new status for the Central Bank and the beginning of a new phase in monetary policy, where primary initiatives shift to dirigiste control.

The new policy and the challenges of 2025

The new policy of manual management is aimed at fulfilling Putin's ambition to maintain economic growth rates (albeit slightly lower) while ensuring macroeconomic stability – an objective he has emphasised frequently in recent times. His frustration with the Central Bank's leadership stems from their belief that achieving this is virtually impossible given the current structure and factors driving growth. Manual management seeks to strike the right balance between economic growth and macroeconomic stability. To achieve this, inflation must decrease faster than the rate of economic growth. However, in 2024, inflation accelerated against the backdrop of only a slight slowdown in growth. If inflation slows down more gradually than growth, it could lead to stagflation – a situation characterised by rising prices alongside economic stagnation. The manual management strategy may slow growth in industries that the government has supported through preferential loans, but it remains unclear how it could stimulate growth in sectors that can supply the consumer market.

The main proponents of the new model for combating inflation are economists from the circle of former Deputy Prime Minister and now Defence Minister Andrei Belousov, who adheres to dirigiste views (→ Re:Russia: In the confrontation between the ‘growth party’ and the ‘Nabiullina party’, the ‘war party’ will prevail). These same economists popularised the term 'supply-side economy,' which Putin now frequently uses in his speeches. This concept suggests that the state should stimulate the saturation of the domestic market with goods and services. Thus, the government faces a challenging task: simultaneously maintaining stable production in the military sector, stimulating the consumer sector, and limiting credit to contain inflation.

A significant challenge for the Russian economy in 2025, beyond the implementation of this delicate balancing act, may be a potential drop in oil prices. As noted earlier, the coming year is expected to see a surplus in the oil market – an excess supply that will not only put downward pressure on prices but could also trigger a price war if OPEC+ abandons its voluntary production cuts (→ Re: Russia: The Spectre of Surplus Looming Over the Shadow Fleet). This surplus is also likely to enhance the effectiveness of Western sanctions targeting Russian oil and gas.

A reduction in export revenues, under any scenario, would lead to decreased budgetary income and further weakening of the ruble. Given the substantial household savings and the insufficient saturation of the domestic market, the inflationary effect of a weakening ruble could be more pronounced than in previous episodes, especially as the Russian economy is now more isolated from international capital markets.

The combination of these circumstances and challenges significantly increases, in our view, the Russian leadership's interest in both a temporary freezing of military operations and a partial easing of sanctions, which has been discussed in recent months in discussions surrounding the ‘Trump plan’.